Italian unity fails to stem market fears over eurozone

Mario Monti secured agreement from Italy's opposition politicians to form an emergency government - but rather than pacifying European markets as expected, Italy's bond yields were pushed over 7pc while those of France, Spain, Belgium and Austria hit fresh highs.

Economists at Schroders warned that Rome's borrowing costs were "unsustainable" even with the help of the European Central Bank (ECB). "With no solution to Italy's problems in sight... we are heading for an almighty crash," they said in a note.

Britain benefited as investors bought gilts, pushing UK borrowing costs down close to record lows. But the damage of the crisis to the UK economy is expected to be made clear on Wednesday with the Bank of England drastically cutting the UK's growth forecast for this year and next year. Economists expect the Bank to use its quarterly inflation report to cut its prediction of 1.5pc growth for 2011 down to 1pc; and the 2.1pc forecast for 2012 to be as much as halved.

George Osborne also warned that the UK is not immune from the crisis. In a letter to Bank of England Governor Sir Mervyn King the Chancellor said: "The threat to the UK economy from the crisis in the eurozone is very serious. The eurozone has the financial capacity to restore stability. So the institutions and leaders of the eurozone need to act without delay."

Alan Krueger, chairman of President Barack Obama's Council of Economic Advisers also called for action. But European leaders seemed intent on digging in. Yves Mersch, a governing council member of the ECB, said that monetising government debt was "tantamount to inflation" and "not feasible", adding that the ECB should not be made the "lender of last resort for governments" but rather states should live up to own responsibilities.

But the bond markets were rapidly closing off capital market funding as an option for some of Europe's biggest economies.

The yield on Italian 10-year bonds soared above the 7pc threshold considered by economists to be unsustainable. They were hauled back in afternoon trading - possibly by ECB intervention - but soon rose again to close at 7.27pc.

Spain was also punished with the yield on 10-year bonds being pushed up 175 basis points to 6.6pc. The impact of the dire bond market sentiment was made clear as Madrid failed to raise its full targets at a scheduled bond auction. The Bank of Spain was hoping to raise €3.5bn but managed just €3.16bn of 12-month and 18-month debt. Investors demanded a yield of 5.15pc, far higher than the 3.6pc at an auction just two months ago.

The fears also hit France, Europe's second biggest economy, which saw its borrowing costs rise to 3.69pc - compared to 1.81pc for Germany and 2.17pc for the UK. David Miller, a partner at Cheviot Asset Management, said: "The weakness in bond markets is symptomatic of the lack of a credible plan in the eurozone... and until the Germans get off the fence and ask the ECB to print euros we can expect the trend to follow in all other Eurozone bond markets."

Evangelos Venizelos, Greece's finance minister, said Athens' new government "must do everything that's required" to avoid bankruptcy and enact the austerity measures agreed in Brussels last month. He said reforms were necessary to secure an €8bn injection of international aid.

In Spain, Mariano Rajoy, favouite to become prime minister after Sunday's election, made similar commitments to reform. Spain's Ibex fell 1.61pc; France's CAC was down 1.92pc; Germany's DAX slid 0.87pc. In London the FTSE 100 was almost flat down 0.03pc.

The Telegraph